After holding on to resounding pressure to reduce repo rates amid falling inflation rates, the Reserve Bank of India finally issued a notification announcing a cut in its repo rate by 0.25 per cent coming into effect immediately. The move comes after the premier agency kept policy rates unchanged for the fifth time in a row in the last concluded fifth bi-monthly policy review in December. While most financial analysts and industry experts were hopeful that a repo rate cut would be announced in the next bi-monthly policy review schedules for the first week of February, the RBI surprised the markets with an early announcement bringing cheer to the financial markets and various industrial chambers.
A Cut in Repo Rates but No Change in CRR: According to the notification the repo rate or the lending rate has been now reduced to 7.75 per cent from the earlier rate of 8 per cent. The RBI announced that it decided to reduce the policy repo rate under the liquidity adjustment facility (LAF). While the policy repo rate has been reduced to 7.75 per cent with immediate effect, the cash reserve ratio or CRR has been kept unchanged at 4 per cent. Cash reserve ratio or CRR is essentially the portion of deposits which banks are required to have in liquid cash with the Reserve Bank of India. With a reduction in the repo rate by 25 basis points, the reverse repo rate has also been adjusted to 6.75 per cent while the marginal standing facility or MSF rate to 8.75 per cent.
What Repo Rate Cut Means for the Common Man: As a direct impact of the RBI policy announcement of reduction in repo rates by 25 basis points most banks are likely to offer the discounted interest rates to its customers. This effectively means that any loan installments are likely to come down this month. While RBI has announced repo rate cut to be effective immediately, some banks may wait a while before offering the benefit to borrowers. Overall with reduced retail inflation and a significant drop in consumer price index, the year 2015 begins on an optimistic note for the common man. Bearing the brunt of heavy price rise and high interest rates for loan EMIs, the common man can now feel a sigh of relief as lower inflation means reduction in price of essential commodities while a rate cut means an effective drop in interest rates for loan EMIs.
Banks to Follow Suit Soon: After the RBI repo rate cut announcement, banks are likely to follow suit and offer a respite for borrowers. The United Bank of India has already announced that it is cutting its base rate by 25 basis points to reach 10 per cent from February 1, 2015. The State Bank of India, India’s biggest public sector bank has also announced that it would offer a rate cut in the coming days. Chanda Kochhar, CEO of ICICI Bank the biggest private lender as well as the finance minster Mr. Arun Jaitely both welcomed the repo rate cut move of the RBI
Repo Rate and Home Loans: While RBI has announced its rate cut, banks are not likely to take much time in offering the same to the borrowers. Banks would need to analyze their costs of funds and bank liquidity conditions before offering the reduced rate cut to its borrowers. The home loan market is likely to witness a positive sentiment as loan EMIs are likely to witness a significant drop.
Example: A decrease in repo rate of 25 basis points translates into a decrease of Rs 15 to Rs 17 per Lakh on the EMI’s. Assuming the interest rate on a 20 year housing loan of Rs 75 Lakh is reduced from 11.25% to 11% it will translate into an approximate saving of Rs 1279 per month in the EMI for the home loan borrower.
The Road Ahead: With a drop in global crude oil prices by as much as 60 per cent and a significant drop in inflation which has gone below the 8 per cent mark targeted by January 2015, the chances of a further reo rate cut cannot be ruled out. Following the current trend, the inflation is likely to be below 6 per cent by January 2016 which has been the target goal for the Reserve Bank of India. While financial experts believe that along with a repo rate cut, a strong reforms push is needed to revive economic growth especially to drive industrial growth, the reduction in lending rates is likely to continue over the year.